The Queen v. Demco Management Ltd., 84 DTC 6065, [1983] CTC 419 (FCTD), aff'd 85 D.T.C 5603, [1986] 1 CTC 92 (FCA)

Collier, J:—This is an appeal from a decision of the Tax Review Board.

The defendant is a private company controlled, at relevant times, by its sole shareholder, Neil de Macedo. In 1964, the defendant, under its former corporate name, built a private hospital in Victoria, BC: Aberdeen Private Hospital. The hospital building was, naturally, constructed on a parcel of land. The defendant owned adjoining unused parcels. A lounge area was added in 1969. The hospital was licenced under the appropriate British Columbia legislation. It operated up to 95 beds or facilities. It was a well run, successful operation, usually with no vacancies.

In 1975 the hospital was sold, as a going concern, to the Province of British Columbia. Included in the package were the land, the improvements (the building), and the furniture, fixtures and equipment. Included also, was the unused or excess land.

The purchase price was $1,125,000. It was agreed the net proceeds of the sale were $1,112,500 (1.1 million).

The dispute between the Minister of National Revenue and the defendant is whether the defendant realized a capital gain on the disposition of the property. The basic question is: what was the adjusted cost base of the property on Valuation Day (December 31, 1971)? To put it in other words: what was the fair market value of the property on that date?

The defendant, in estimating its income tax for the applicable year, took the position there had been no gain: the market value on December 31, 1971 was not less than, or was the same as, the amount realized on the disposi- tion of the property in 1975. The Minister of National Revenue took a different view. By reassessment, dated May 30, 1978, the Minister alleged the defendant had realized a capital gain of $400,000. At the time of the assessment, the Minister calculated the Valuation Day value as follows:

Later, the Minister revalued the properties at $756,000 and the gain at $356,500. Disposal expenses of $14,152.41 were allowed.

At the trial before the Tax Review Board, the presiding member accepted the evidence of an appraiser, David J Clark, who testified on behalf of the taxpayer. Clark used an earnings or income approach, and arrived at a value of the property, as a package, of $1,131,000 (approximately 1.1 million). The member of the Board accepted Clark’s evidence over that of W H Southward, an appraiser called on behalf of Revenue. Southward had used the cost approach only, in arriving at value. The member concluded his reasons as follows:

. . . For these 6 reasons, the Board prefers to rely on Mr Clark’s appraisal and the value of the property on V-day and under review, is fixed at $1,131,000.

The Minister then brought this appeal to this Court.

In paragraph 6 of the defence, the defendant alleged:

6. The loss on the sale is properly calculated and the cost and sale price properly allocated as set out in paragraph 4 of the Statement of Claim herein.

The calculation of the capital loss referred to was as follows:

which amounts were apparently allocated between land and building by the Defendant as follows:

	Proceeds	V-Day Value
Land	$ 662,500.00	$ 662,500.00
Building	450,000.00	450,000.00
Equipment	12,500.00	12,500.00
Total	$1,125,000.00	$1,125,000.00

Before dealing with the opinions of the various appraisers, I shall recount certain other relevant and important testimony.

In 1972, a Mr Marquardt entered into negotiations with de Macedo to buy the Aberdeen Private Hospital as a going concern. Marquardt, too, was in the private hospital business. He was a successful operator. He knew the Aberdeen Hospital as an efficient and successful business. After some negotiations, he made an offer to de Macedo to buy the operation for approximately $1.1 million. The parties came very close to concluding a sale and purchase. But Marquardt eventually discontinued negotiations. There was a change of government in British Columbia in the summer of 1972. Marquardt was worried about the views the incoming government might have in respect of the operation of private hospitals.

The package, in the offer by Marquardt, was the same package sold by the defendant in 1975 for approximately $1.1 million.

The Minister does not dispute those salient facts. It is accepted the offer in 1972 is relevant and cogent evidence as to the market value, on December 31, 1971, of the hospital as a going concern.

The Minister, on this appeal, relied on the evidence of Southward. That appraiser had made some changes and additions in and to the evidence given before me, as compared with the evidence he gave to the Tax Review Board. There, he had used the cost approach, solely, to arrive at the value of the property disposition.

In respect of land, he used comparable sales. He arrived at a cost of $2.70 per square foot. In his breakdown in respect of the building, he used replacement cost with allowances for depreciation.

His ultimate figures were as follows:

For the appeal in this Court he had been asked, in addition, to evaluate the property as a going concern. He arrived at a figure of $1,110,000 (1.1 million).

He went on to allocate that amount as follows:

The difference between $1,110,000 and $799,000, an amount of $311,000, he attributed as follows: “Remaining Good Will Element of Value” or “Intangible Value”.

Southward used, for his calculation, the furniture, fixtures and equipment value testified to by another witness, Lombardo.

Dennis Turnbull, another valuator, gave evidence on behalf of the plaintiff. He used the Marquardt offer as a basis of arriving at a value, in 1971, of the business and the business assets. He came to $1.02 million. But he considered this next step necessary:

The Fair Market Value of the tangible assets must be deducted from this amount to determine the intangible asset value.

He then relied on Southward’s allocation of value to land and improvements, plus the amount, earlier mentioned, of $43,000 for furniture, fixtures and equipment. After subtracting those figures, he concluded there was an intangibles value, as of December 31, 1971, of $330,000.

He also used, as a partial check on his basic approach, a pure earnings valuation. He arrived, by that method, at a going concern value of approximately $1 million.

The third appraiser, Lombardo, on a cost less depreciation method, valued the furniture, fixtures and equipment at $43,000. He did not use the cost approach in respect of 76 hospital beds; there, he used a market approach.

I turn to the expert evidence adduced for the taxpayer.

Clark’s testimony in chief was the same as given in his report filed as an exhibit with the Tax Review Board. He used the earnings approach to calculate the value of the business and its accompanying assets as a going concern. His conclusion, as to value on December 31,1971, was $1,131 million.

Clark made, as well, a calculation, on a cost method, as to the value of the land and the value of the improvement. In that exercise, he arrived at $298,000 for the land as. if vacant; he estimated approximately $628,000 as the depreciated replacement cost of the improvement.

But, in arriving at his value of the total package as of December 31, 1971, he disregarded those methods and those calculations. He used solely the income approach.

In his final valuation, he made no allocation among land, improvements, and furniture, fixtures and equipment. He said it was illogical to do this. The operation had value as a complete package; it was unrealistic to treat the land as being vacant; it was in fact occupied by a building with a particular use with a particular value to someone interested in the private hospital business. He applied the same reasoning for rejecting a separate allocation for improvements. He relied on the total package concept. He did not assign any real value to intangibles, or good will.

I agree with, and adopt, the evidence and opinions of Clark. I endorse the view of the presiding member of the Tax Review Board in accepting and relying on that testimony.

The only practical, businesslike and realistic way to arrive at the value, as of December 1971, of what was there then (and what was ultimately sold in 1975), was by the income-going concern approach.

In the circumstances of this particular business operation, no right thinking vendor or purchaser would consider purchasing the land only (as if vacant). Nor would those hypothetical persons consider selling or buying the building alone. Realistically, there was no actual market place for either transaction.

The same comments apply to the furniture, fixtures and equipment of Aberdeen hospital. A specific valuation might be required on an offer to purchase as a separate entity on, say, a liquidation or distress sale.

The Minister and his appraisers, Southward and Turnbull, calculated, as I have recounted, an amount for “intangibles”. At trial it was argued these large amounts ($311,000 or $330,000) were substantiated by the holding of the licence to operate as a private hospital, and by good will.

There is no satisfactory evidence to support that assumption. The two witnesses in the private hospital business, de Macedo and Marquardt, both in their negotiations, and as a practical matter, put little or no value on the holding or retention of the licence, or on good will.

It is true there was some limitation on the issuing of licences by the provincial government. But the real control, by the provincial government, once a licence was issued, was the possibility of non-renewal if the operation was unsatisfactory to government inspectors, or to the appropriate Minister. The provisions of the then Hospital Act, RSBC 1960, c 178, dealing with private hospitals, set out, in sections 7 to 16, the provisions as to licencing. Transfers of licences were permitted with the endorsement of the appropriate minister (see section 14). The provisions for revocation were set out in section 16, as well as the procedure in respect of revocation.

I accept the evidence of Marquardt that the Aberdeen operation was a good and efficient one; that the continuance of the licence on any change of ownership to a reputable buyer was almost a matter of course; the licence had little or no monetary value. I accept, also, the evidence of Marquardt and de Macedo that in their negotiations in 1972, they assigned little or no value to intangibles.

There is no real difference in the overall values of Southward, Turnbull and Clark, as to the value of the Aberdeen Private Hospital as a going con- cern. In argument, it was conceded the going concern value, as of Valuation Day, could be taken as approximately 1.1 million dollars — the same approximate value on the sale of the business in 1975.

What the Minister has tried to do, through his appraisers, is to isolate or extract out of the overall value of the business and its assets, a breakdown of the package into various components. The Minister has, by using different appraisal techniques, as opposed to one overall technique such as that used by Clark, allocated a value to various components. It is noteworthy none of the plaintiff’s appraisers used any particular technique to try and calculate, by some businesslike approach, the value of the so-called intangibles. The method used, to put it crudely, was one of addition and subtraction.

I suspect one reason for the employment of this breakdwn process is a view by Revenue that capital gains, or losses, specifically or implicitly under the Income Tax Act, cannot be realized on “nothings” or intangibles.

There is a further criticism of the Minister’s position. The plaintiff’s appraisers calculated a substantial intangibles value as of December 31, 1971. To arrive at a capital gain, they assumed no value to intangibles at the date of disposition; the intangibles have somehow disappeared. The result is an unsupported increase, by 1975, of the land, improvement, and equipment and fixtures value. There was no evidence, other than general comments as to inflation, that these particular parcels of land, and this particular improvement, had increased in market worth from 1971 to 1975.

Mr Heinrich, counsel for the plaintiff, contended it was incumbent upon the Minister, and indeed upon this Court, to allocate value, at least among land, building, and furniture, fixtures and equipment. Mr Heinrich candidly admitted there are no specific words, or other provisions, in the Income Tax Act requiring this be done. He argued the whole scheme of the Act implies such allocations should be made.

I do not agree.

The only thing in issue, between the parties and before the Court in this particular case, is whether there had been a gain on the disposition, in 1975, of the property. I use the term “property” in its widest sense. (See also the definition in subsection 248(1) of the statute). The defendant, in estimating its tax, pursuant to section 151 of the Act, had first to determine whether a capital gain was made on this particular transaction, and then the amount of the gain. There is no provision anywhere which requires a breakdown between land, building and other components for that precise purpose.

It may well be in matters of recapture of capital cost allowance, some allocation among land, improvements, and fixtures might have to be made in the case of this taxpayer, or in other cases. But that is not the point before the Court. The question is the value of the gain. Not the value of the components of the gain.

It might also be, in the case of a private purchaser of a business and its assets, such as that sold here, that a private purchaser (taxpayer), in order to claim capital cost allowance, may have to allocate values among land, buildings and equipment.

All that, in my opinion, does not impose any requirement on the taxpayer, Minister or the Court to allocate, among the components in this case, the gain, if any.

If an allocation were necessary, it seems to me the allocation suggested by the defendant is supported by the evidence. There is no difference be- tween the package which existed in 1971, and that which was sold in 1975. In the arm’s length transaction of 1975, the parties to the sale made an allocation of the purchase price as follows: (see Schedule I to Exhibit 6):

Both parties, obviously, attached no value to so-called intangibles.

The evidence, earlier referred to, of de Macedo and Marquardt, supports that position. There was no real value in ingangibles at either of the relevant dates. The land, improvements, and the remaining tangible assets, were all interrelated. They produced a gross overall value.

The appeal is dismissed. The decision of the Tax Review Board is confirmed. The defendant is entitled to its costs of this appeal.

Appeal dismissed.